When someone buys real estate and needs a loan to pay for some or all of the purchase price, it's common for the lender to order an appraisal of the property during the closing process.
Here are five things property buyers need to know about real estate appraisals.
1. We already agreed on a purchase price. Why do we need an appraisal?
When a bank loans you money to buy property, your obligation to pay back that money generally is secured by a mortgage. The mortgage is an agreement that gives the bank the right to foreclose upon your property and sell it to somebody else if you default on the loan. If that were to happen, the bank would use the sale proceeds to pay itself back, and you would end up pocketing whatever is left over.
From the bank's perspective, the mortgage process only works if the value of the property is at least as much as the value of the loan they're writing for you to purchase it. (If the property is worth less, the bank would lose money if it ever needed to sell.) Most banks also want some additional buffer to account for fluctuations in the real estate market. To assure themselves of this value, banks want an objective opinion from a professional who's not actually involved in the transaction itself. That's where an appraiser comes in.
2. What happens during the appraisal?
During an appraisal, a licensed real estate appraiser will visit the property and conduct an analysis to determine its market value. This process is similar in some ways to how a listing real estate agent might do a comparative market analysis to suggest a list price for a property, but it's more sophisticated. Generally, the appraiser will compare the subject property to other similar properties that have been sold recently in the same area. Or, in the case of rental property, the appraiser might look to what similar properties are renting for in the same area to estimate the property's value. Unlike a listing appointment or a home inspection, the buyer usually is not present at the property for the appraisal.
The thoroughness of the appraiser's analysis can vary and usually depends on lender requirements and the type of loan product. Typically, the appraiser will do a basic walk-through of the property, making notes of important features and taking a few photos. This allows the appraiser to get a general feeling for what features might add to or subtract from the property's value, and it also allows them to better compare the property to other properties within the market.
However, sometimes the appraiser's inspection of the property is more rigorous. For example, if a borrower needs FHA financing (where loans are being back-stopped and loan-to-value ratios are very high), the appraiser may be asked to verify that the property is in excellent condition and that it doesn't have condition issues like peeling paint. On the other hand, there are certain cases where the lender only wants a rough estimate of value, allowing for a so-called "drive-by appraisal" where the appraiser doesn't even enter the property. But, this is not typical in today's market.
Sometime after the appraisal, the appraiser usually issues a written report back to the lender. This report documents the appraiser's observations of the property, explains the research and rationale that they used in their analysis, and sets forth their estimate of value. The thoroughness of this report generally varies in the same way as the appraisal itself, but most reports are fairly detailed and comprehensive.
3. When does the appraisal happen?
Usually, the appraisal is scheduled after there is a signed Purchase and Sale Agreement between the buyer and the seller. That's because most lenders don't start the formal underwriting process for a property until they know there is a solid legal agreement in place. The appraisal usually takes about a half hour of time, and a report is usually available within about a week.
4. Who pays for the appraisal?
The buyer customarily pays the fee for the appraisal. This fee usually ranges from about $300 to $500, depending on the lender and appraiser. Sometimes the fee must be paid out-of-pocket by the buyer up-front or when services are rendered, as with a home inspection. But it's common for the lender to add the appraisal fee to the costs the buyer funds at closing (which may be paid out-of-pocket by the buyer, with or without contributions by the seller, or rolled up into the amount of the loan).
The buyer usually does not have much control over the selection of the appraiser or the fee they charge. That's usually up to the lender. However, it's always a good idea to ask your lender up-front about how the process will work, what you're being asked to pay for, and when you're being asked to pay it.
5. What happens if the appraisal report comes back and it's too low?
Lenders typically don't provide a copy of the appraisal report to their clients automatically. Therefore, the first step is to ask your lender for a copy of the written appraisal report.
Take a good look at the report and make sure that all of the information about your property is accurate. Appraisers are human, so it's possible for a mistake to be made. If you think there's something wrong, don't hesitate to ask for the error to be corrected and factored back into the analysis. It's also acceptable to – respectfully – challenge the more subjective analysis that's contained in an appraiser's report, particularly if you think there is an observation or comparison that's truly unfair. Most appraisers have done their homework and have a good reason for the analysis they provide, but it's always possible that there's something they overlooked or didn't factor appropriately. In rare cases, the report might be redone or a new report might be ordered.
To avoid issues later on, it is appropriate to provide an appraiser with helpful information about the property, or even the local real estate market, during the appraisal process. That's especially true if that data isn't readily apparent or if the appraiser is unfamiliar with the area. For example, if there are some really important features about the house that you're afraid the appraiser might honestly miss, it's fine for your agent to bring these features to their attention. Likewise, if there is something unusual about a recent sale in the area that would make it a bad comparison, it's fine to let the appraiser know that, too.
However, be careful about overdoing it. After all, appraisers are professionals, and you should trust in their basic ability to observe the property and factor it into the local market. You don't want to look like you're trying to sway the appraiser's professional opinion, which is never appropriate. (For example, it's not o.k. to say, "Hey, I really need this property to appraise for $500,000, so do what you can to hit that number.") When in doubt, just let the appraiser do their job and trust that they know what they're doing.
One common problem these days is the fact that the real estate market is competitive. Situations like 'bidding wars' tend to push prices up, up, up. The end result could be a price that the buyer and seller accept between themselves, but which isn't really defensible within the context of the real estate market. If an appraiser concludes as much, the only alternative might be for the purchase price to be altered, or for the buyer to bring more cash to the closing table to make up the difference. In rare cases, when faced with an inadequate appraised value and unwillingness/inability to address the situation between the buyer and seller, the deal could fall through. That's why it's always a good idea to make sure that the offer you place for a property is realistic within the scheme of things, and to make sure that your offer has financing contingencies in place.
Appraisals are a necessary part of the real estate financing process, and they can provide helpful information to a buyer and a seller beyond their subjective agreement. But, buyers should always be sure to ask a lot of questions about the process to satisfy themselves with the result of the appraisal and their subsequent ability to qualify for a mortgage.
